A colleague of mine, Jon, posed an interesting question on why it is that bad news today for the US economy (worst existing home sales number since ‘99) could be good for the US dollar.
Recall now the long-awaited death of the American consumer. Consumer spending has accounted for two-thirds or more of our economic growth and also for our huge trade deficit (as Americans have kept on partying like it’s 1999 and importing more than we export). Much of that spending has come in the form of Mortgage Equity Withdrawal (MEW) as Americans have treated their homes like an ATM. That works only as long as prices keep going up. But now we all know that has reversed.
The only surefire way throughout economic history to cure a trade deficit is a good recession. So if the housing numbers keep proving worse than expected and markets hear the death knell of the American consumer, is that necessarily bad for the US dollar?
Consider that if we cut our consumption drastically, imports will go way down and possibly dip below exports, correcting our trade balance. If the same amount of investment keeps coming in to the US because investors seek the safe haven of the US during a global slowdown, then the dollar would gain value.
Throughout the economic boom of the past 5 years the US dollar has been dropping, and perhaps throughout a recession we’ll see it rise. Take a moment to think beyond the talking heads on the news and consider that one can’t have it both ways: One can’t just say about the dollar that good news is bad news and bad news is bad news.
We finally have a sharp pullback in the carry trade pairs after their near vertical bounce and V bottom pattern off the mid-August spike down low. Many eyes are on GBP/JPY, as it’s the only one even close to threatening the mid-August low. Normally a retest is typical in the few weeks following the low to create another common bottoming formation, the W bottom, or to break below and turn into a downtrend. So we are running a bit late for the retest, but nonetheless, all eyes are on support levels.
First though, GBP/JPY will have to attack the consolidation in mid 228 range, before the another stab toward 219 is likely. Much has been made of the negative correlation with the Dow Jones stock average and the Yen, where risk aversion cause the Dow to weaken while the Yen strengthens. There are ample signs that speculation has returned to stocks, for example by overly bullish sentiment surveys or investors concentrating buying in higher beta stocks.
Clearly the jury is now in that global economic growth is slowing. However, after the great rise in Yen in August on the credit and stock markets turmoil, the extreme short position in the Yen remains greatly reduced, so there may not be as ample ammunition now for a sustained spike in the Yen.
Keep an eye on key support areas on GBP/JPY and trend line support on the others. And of course with all the talk about the 20 year anniversary of the Crash of ‘87 in stocks, however unlikely it always it for such a crash, traders will be watching short term positions very closely with stops in place to protect the downside. Whatever happens, we should know within a few short weeks if this is a just a run-of-the-mill pullback or the beginning of a sustained downtrend.
